The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation

With all the attention focused on the problems of the savings and
loan industry in recent years, casual observersand even expert
economistshave probably felt overwhelmed at various times.
What we've needed is one source that provides an encyclopedic rendering
of the S&L debacle; and, in Lawrence White's new book, that
is exactly what we get. Anyone with a serious interest in financial
intermediaries, and the regulation of them, is advised to read this
book.

However, my recommendation is not unqualified. On the one hand,
while I acknowledge the value of this book for its succinct explanation
of the S&L crisis, on the other hand, I expected more. Lawrence
White, an economist well-known for his professionalism and integrity,
served on the Federal Home Loan Bank Board (FHLBB) from November
1986 through August 1989. Certainly, I did not expect any tabloid-style
revelations of S&L treachery from White, but I had hoped that
his tenure at the FHLBB during those critical years would have produced
new insight into the causes and consequences of the crisis. Unfortunately,
there is no evidence of such insight here.

White provides an accurate description of recent events that led
to the current S&L problem. Before 1980, 75 percent of S&Ls'
assets were held in long-term mortgages. When interest rates shot
up through the early '80s, most S&Ls were caught between the
"rock" of paying high short-term rates to depositors and the "hard
place" of receiving low-interest payments from their home loans.
When the real estate and energy markets tumbled, especially in the
Southwest, S&Ls felt additional pressure. To make matters worse,
the response from regulators at the time was to reduce the number
of federal examiners, to increase the asset powers (and hence the
gambling opportunities) of S&Ls, and to devise creative accounting
methods that kept failing S&Ls open long after they were rightfully
bankrupt.

Moral hazard was rampant. Faced with the certain demise of their
institutions if events stayed their course, and buoyed by the presence
of federally insured funds, S&L executives played high-stakes
poker with depositors' funds. Most lost. Deregulation provided new
and enticing methods to earn money, but unsophisticated mortgage
lenders were generally unsuccessful, if not downright corruptthe
headlines are full of stories about illegal S&L dealings. In
the meantime, real estate markets continued to deteriorate and supervision
remained lax.

Bad judgment and bad luck are in abundance throughout this saga
and many are to blame, as White duly notes, but the question remains:
Why did policymakers err so consistently? From 1966 to 1985, nearly
every regulatory or legislative decision regarding S&L policy
was misguided, White claims. As far as I'm concerned, the fault
lies not only with the decisions but with the policymaking coalition
that made those decisions.

In a section describing his recommendations for change, White
rightly makes a case for enhanced regulatory powers, but he abandons
the benefits of market discipline by advocating 100 percent deposit
insurance. This is troubling, especially in light of the fact that
we are passing through an era of financial troubles wherein regulatory
oversight largely failed, and defacto 100 percent deposit
insurance helped create an environment of financial irresponsibility.
Advocating stricter regulation with 100 percent deposit insurance
is like warning a paroled criminal that jail sentences have been
toughened while at the same time handing him a loaded gun.

White also decries the lack of "voices in the wilderness" in the
early 1980s that, he seems to imply, should have warned us about
the inherent problems of the DIDMCA and the Garn-St. Germain Act.
But this claim comes off as a weak excuse for policymakers' mistakes.
Contrary to White's argument, there were warnings that the FDIC
and FSLIC were heading for trouble. Notable, among others, was John
Kareken's prophetic article "Deposit Insurance Reform or Deregulation
is the Cart, Not the Horse," published in the Minneapolis Fed's Quarterly Review, Spring 1983. This oft-cited article
clearly, and well before the problem was publicly recognized, warned
of the impending dangers of our deposit insurance system.

So, while White effectively retraces the steps that led to the
current S&L mess, and in so doing provides a warning for the
future, he misses the chance to go one step further and investigate
the policy apparatus that allowed such a debacle to occur. Even
so, this book is a must read. It's a one-source guide to the thrift
industry and the recent dilemma, and I know I will refer to it frequently.